This blog covers financial, political and other topics the author gets the urge to write about. It does not provide personal financial, legal or other advice. Consider consulting a personal professional adviser before making any decisions. Copyright (c) 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 by Leonard W. Wang. All rights reserved.

Thursday, July 12, 2012

Stocks Are Not Cheap

Forget what the bulls have to say. The Federal Reserve Bank of New York just released a study showing that over 50% of the increase in the S&P 500 since 1994 is due to Federal Reserve actions. http://www.cnbc.com/id/48165921. Without central bank intervention, the market as measured by the S&P 500 would be around 600 instead of today's close at 1334.76. In other words, based on economic fundamentals, stocks are overpriced by more than 100%. That's a sell if there ever was one. It looks like all the retail investors who are abandoning the market aren't so dumb after all.

One may quibble with the Fed's methodology. Its staff looked at market activity in the 24 hours before the Fed announced Open Market Committee decisions, totaled and netted the market movements, and came up with the more than 50% figure. It's certainly possible that some portion of the market movements in the 24 hours before announcements of Open Market Committee decisions could be attributed to other causes. In fact, it would be surprising if the only discernible reason for these movements over an 18-year time span was anticipation of the Fed. But even if only 25% of the S&P's rise since 1994 is due to the Fed, stocks still remain seriously overpriced. They're a buy only if you have faith in the efficacy of central banks. And history does not vindicate such confidence.

Of course, the Fed isn't recommending that investors sell. It's certainly not about to undo all the accommodation and easing it's instituted over the past 18 years, not for quite a while. So the central bank put for stocks will remain in place for now. But ultimately, the government, including the almighty Fed, cannot prescribe stock prices (even though it's acting like it desperately wants to). If you choose to invest in stocks, expect volatility (especially if things in Europe continue their slide into the septic system) and a long wait before any big payoff arrives.

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